Our service gross margin percentage increased in fiscal 2009 compared with fiscal 2008, primarily due to higher margins for both technical
support and advanced services, and also due to the mix of service revenue, with advanced services constituting a lower proportion of total service revenue. The higher margins for both technical support and advanced services were attributable
primarily to the growth of our service revenue as well as to certain cost-control initiatives that have helped to limit costs. For advanced services, the higher gross margins also benefited from lower costs associated with delays in certain
projects.

Our service gross margin normally experiences some fluctuations due to various factors such as the timing of technical support service
contract initiations and renewals, our strategic investments in headcount, and resources to support this business. Other factors include the mix of service offerings, as the gross margin from our advanced services is typically lower than the gross
margin from technical support services. Our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures, or other reasons, may cause advanced services to increase to a higher
proportion of total service revenue.

Fiscal 2008 Compared with Fiscal 2007

Service gross margin percentage decreased slightly in fiscal 2008 compared with fiscal 2007, due primarily to advanced services constituting a higher proportion of total service revenue in fiscal 2008.

Our service gross margin percentage increased in the third quarter and the first nine months of fiscal 2009, compared with the corresponding periods of fiscal 2008, primarily due to higher technical support and advanced services margins as
well as advanced services constituting a lower proportion of total service revenue. The increased margins for technical support and advanced services were attributable primarily to the growth of our service revenue at the same time as certain cost
control initiatives have helped to limit costs. For advanced services gross margins also increased due to delays in certain projects. However, our service gross margin may decline in future periods due to the timing of our strategic investments in
headcount and resources to support this business. Service gross margin normally will experience some fluctuations due to various factors such as the timing of technical support service contract initiations and renewals. Also, service gross margin
from our advanced services is lower than the service gross margin from technical support services. In future periods, we will experience an unfavorable impact to our service gross margin if revenue from advanced services increases to a higher
proportion of total service revenue, as a result of our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures, or for other reasons.

Our service gross margin percentage increased in the second quarter and the first six months of fiscal 2009 compared with the corresponding periods of fiscal 2008 primarily due to higher technical support and advanced services margins and
the fact that advanced services constituted a lower proportion of total service revenue. Technical support margins will experience some variability due to various factors such as the timing of technical support service contract initiations
and renewals and the timing of our strategic investments in headcount and resources to support this business. Our service gross margin from technical support services is higher than the service gross margin from our advanced services, and
our revenue from advanced services may increase to a higher proportion of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures. Additionally,
we have continued to invest in building out our technical support and advanced services capabilities in the Emerging Markets theater.

Our service gross margin percentage decreased
in the first quarter of fiscal 2009 compared with the first quarter of fiscal 2008 primarily due to lower technical support margins and the fact that advanced services constituted a higher proportion of total service revenue. Technical support
margins will experience some variability due to various factors such as the timing of technical support service contract initiations and renewals, and the timing of our strategic investments in headcount and resources to support this
business. Our service gross margin from technical support services is higher than the service gross margin from our advanced services, and our revenue from advanced services may continue to increase to a higher proportion of total service
revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures. Additionally, we have continued to invest in building out our technical support and advanced services
capabilities in the Emerging Markets theater.

Our service gross margin percentage for fiscal
2007 decreased from fiscal 2006, primarily due to strategic investments in headcount as well as advanced services representing a higher proportion of total service revenue. Additionally, we have continued to invest in building out our technical
support and advanced services capabilities in the Emerging Markets theater.

Service Gross Margin

Our servicegross margin percentage decreased slightly in fiscal 2008 compared with fiscal 2007 due primarily to advanced services constituting a higher proportion of total service revenue in fiscal 2008. Our service gross margin from technical support servicesis higher than the service gross margin from our advanced services, and our revenue from advanced services may continue to increase to a higher proportion of total service revenue due to our continued focus on providing comprehensive support to ourcustomers networking devices, applications, and infrastructures. Additionally, we have continued to invest in building out our technical support and advanced services capabilities in the Emerging Markets theater.

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2008 Annual Report 29

Managements Discussion and Analysis of Financial Condition and Results of Operations

Our service gross margin percentage decreased slightly in the third quarter and first nine months of fiscal 2008 compared with the corresponding periods of fiscal 2007
due primarily to advanced services. Our service gross margin from technical support services is higher than the service gross margin from our advanced services, and our revenue from advanced services may continue to increase to a higher proportion
of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures. Additionally, we have continued to invest in building out our technical support and
advanced services capabilities in the Emerging Markets theater. Service gross margin will typically experience some variability over time due to various factors such as the change in mix between technical support services and advanced services, as
well as the timing of technical support service contract initiations and renewals and the timing of our strategic investments in headcount and resources to support this business.

Our service gross margin percentage decreased slightly in the second quarter and first six months of fiscal 2008 compared with the corresponding periods of fiscal 2007
due primarily to advanced services. Our service gross margin from technical support services is higher than the service gross margin from our advanced services, and our revenue from advanced services may continue to increase to a higher proportion
of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures. Additionally, we have continued to invest in building out our technical support and
advanced services capabilities in the Emerging Markets theater. Service gross margin will typically experience some variability over time due to various factors such as the change in mix between technical support services and advanced services, as
well as the timing of technical support service contract initiations and renewals and the timing of our strategic investments in headcount and resources to support this business.

Our service gross margin percentage was flat in the first quarter of fiscal 2008 compared with the first quarter of fiscal 2007. Service gross margin will typically
experience some variability over time due to various factors such as the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals and the timing of
our strategic investments in headcount and resources to support this business. Our service gross margin from technical support services is higher than the service gross margin from our advanced services, and our revenue from advanced services may
continue to increase to a higher proportion of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures. Additionally, we have continued to
invest in building out our technical support and advanced services capabilities in the Emerging Markets theater.

Service gross margin for fiscal 2006 included the effect of employee share-based compensation expense under SFAS 123(R), which reduced service gross margin percentage by approximately 2.5% compared with fiscal 2005.
Our service gross margin benefited from higher revenue on a relatively stable cost base.

34 Cisco Systems, Inc.

Managements Discussion and Analysis of Financial Condition and Results of
Operations

Our service gross margin percentage in the third quarter and first nine months of fiscal 2007 decreased from the corresponding periods of fiscal 2006, primarily due to
strategic investments in headcount as well as advanced services representing a higher proportion of service revenue. Additionally, we have continued to invest in building out our technical support and advanced services capabilities in the
Emerging Markets theater.

Service gross margin will typically experience some variability over time due to various factors such as the change in mix
between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals and the timing of our adding personnel and resources to support this business. Our service gross margin
from technical support services is higher than the service gross margin from our advanced services and our revenue from advanced services may continue to increase to a higher proportion of total service revenue due to our continued focus on
providing comprehensive support to our customers networking devices, applications, and infrastructures.

Our service gross margin percentage in the second quarter and first six months of fiscal 2007 decreased from the corresponding periods of fiscal 2006, primarily due to strategic investments in headcount as well as
advanced services representing a higher proportion of service revenue in the second quarter and first six months of fiscal 2007 compared with the corresponding periods of fiscal 2006. Additionally, we have continued to invest in building out our
technical support and advance services capabilities in the Emerging Markets theater.

Service gross margin will typically experience some
variability over time due to various factors such as the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals and the timing of our adding
personnel and resources to support this business. Our service gross margin from technical support services is higher than the service gross margin from our advanced services and our revenue from advanced services may continue to increase to a higher
proportion of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures.

Our service gross margin
percentage benefited from lower employee share-based compensation expense. Service gross margin will typically experience some variability over time due to various factors such as

the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and
renewals and the timing of our adding personnel and resources to support this business. Our service gross margin from technical support services is higher than the service gross margin from our advanced services and our revenue from advanced
services may continue to increase to a higher proportion of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures.

Service gross margin percentage decreased by 1.8% compared to fiscal 2004. The decrease in service gross margin percentage was primarily due to
increased investments in the service portion of our business during fiscal 2005. One specific area of investment is advanced services, comprising highly specialized employees. As we add personnel and resources to support growth in this business, our
service margins will typically be adversely affected in the near term. We also added investments in our technical support business during fiscal 2005.

Service gross margin
during the third quarter and first nine months of fiscal 2006 includes the effect on our service costs of sales of $28 million and $90 million, respectively, of stock-based compensation expense related to employee stock options and employee stock
purchases under SFAS 123(R), which reduced service gross margin percentage by 2.4% and 2.7% during the respective periods. There was no stock-based compensation expense related to employee stock options and employee stock purchases in the
corresponding periods of fiscal 2005. Our service gross margins benefited from higher revenue on a relatively stable cost base. Our service gross margin from technical support services is higher than the service gross margins from our advanced
services. Service gross margin will typically experience some variability over time due to various factors such as the change in mix between technical support services and advanced services, as well as the timing of technical support service
contract initiations and renewals and the timing of our adding personnel and resources to support this business. Our revenue from advanced services may continue to increase to a higher proportion of total service revenue due to our continued focus
on providing comprehensive support to our customers networking devices, applications, and infrastructures.

Service gross margin during the second quarter and first six months of fiscal 2006 includes the effect on our service costs of sales of $28
million and $62 million, respectively, of stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123(R) which reduced service gross margin percentage by 2.6% and 2.9% during the respective periods.
There was no stock-based compensation expense related to employee stock options and employee stock purchases in the corresponding periods of fiscal 2005. Our service gross margin from technical support services is higher than the service gross
margins from our advanced services. Service gross margin will typically experience some variability over time due to various factors such as the change in mix between technical support services and advanced services, as well as the timing of
technical support service contract initiations and renewals and the timing of our adding personnel and resources to support this business. Our revenue from advanced services may continue to increase to a higher proportion of total service revenue
due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures.

Service gross margin decreased by 1.3% but increased $80 million in absolute dollars. Service gross margin will typically experience some variability over
time due to various factors such as the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals.

Service gross margin includes the effect on our service cost of sales of $34 million of stock-based compensation expense related to employee
stock options and employee stock purchases under SFAS 123(R) which reduced service gross margin percentage by 3.2%. There was no stock-based compensation expense related to employee stock options and employee stock purchases in the first quarter of
fiscal 2005. Our service gross margin from technical support services is higher than the service gross margins from our advanced services. Service gross margin will typically experience some variability over time due to various factors such as the
change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals and the timing of our adding personnel and resources to support this business. Our revenue
from advanced services may continue to increase to a higher proportion of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures.

Service gross margin decreased by 1.3% but increased $80 million in absolute dollars. Service gross margin will typically experience some variability over time due to
various factors such as the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals.

Service gross margin percentage decreased by 1.8% and 1.6% during the third quarter and first nine months of fiscal 2005, compared with the third quarter and nine months of fiscal 2004, respectively. The decrease in
service gross margin was primarily due to increased investments in the service portion of our business during fiscal 2005. One specific area of investment is advanced services, comprising highly specialized employees. As we add personnel and
resources to support growth in this business, our service margins will typically be adversely affected in the near term. We have also added investments in our technical support business.

Our service gross margin from technical support services is higher than service gross margin from our advanced services. Service gross
margin will typically experience some variability over time due to various factors such as the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and
renewals and the timing of our adding personnel and resources to support this business. Our revenue from advanced services may continue to increase to a higher proportion of total service revenue due to our continued focus on providing comprehensive
support to our customers networking devices, applications, and infrastructures.

Service gross margin decreased by 3.2% and 1.4% during the second quarter and first six
months of fiscal 2005, compared with the second quarter and first six months of fiscal 2004, respectively. The decrease in service gross margin was primarily due to increased investments in this portion of our business during fiscal 2005. One
specific area of investment is advanced services, comprising highly specialized employees. As we add personnel and resources to support growth in this business, our service margins will typically be adversely affected in the near term. We have also
added investments in our technical support business.

Our service gross margin
from technical support services is higher than service gross margin from our advanced services. Service gross margin will typically experience some variability over time due to various factors such as the change in mix between technical support
services and advanced services, as well as the timing of technical support service contract initiations and renewals and the timing of our adding personnel and resources to support this business. Our revenue from advanced services may increase to a
higher proportion of total service revenue due to our continued focus on providing comprehensive support to our customers networking devices, applications, and infrastructures.